Pay Ratio

Michael Milken (image: US Congress, 2006)
Having thought it over for seven years, government took a step. On September 21, 2017, the SEC Securities and Exchange Commission announced that, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed into law in 2010, publicly traded corporations must disclose publicly the “median employee” compensation along with the pay of the “principal executive officer”, and the ratio of the highly paid officer’s pay to the median employee pay, every year beginning with the company’s fiscal year that began in 2017.

Economist Piketty wrote in 2014 the supercompensation of senior corporate executives, exacerbated by rent seeking, contributed importantly to the disparity of incomes in advanced economies, especially in the United States. The Occupy Wall Street movement, chanting “We are the 99 Percent!” protested the disparity in 2011. Nobel economists Akerlof and Shiller in 2015 attributed to Michael Milken the beginning of supercompensation in the 1980s as the indirect effect of his pioneering corporate acquisitions financed by junk bonds. Nobel economist Stiglitz in 2013 wrote of corporate CEOs Chief Executive Officers taking a disproportionately large share of the wealth of the companies over which they presided. And now, the US government has acted to measure supercompensation.

Early reports are in. I’ve looked at 24 of them. (You can find them yourself by searching up the company website, finding the link to “Investor Relations” or “Investors”, then the link to “SEC Filings”, and then the link to the 2018 “DEF 14A” or “Proxy”. (Or you can just apply your search engine to all those keywords plus the name of the company.) Here I present some highlights of what I found.

The regulation requires companies to report the CEO’s total compensation, the median employee compensation, and the ratio. For example, for AXP American Express, in 2017, the CEO got $19m, the median employee got $57k, and the reported ratio was 327.

We suppose a company would prefer to report a low ratio, because the executives wouldn’t want to appear overly avaricious. A company can report a lower ratio than you might expect if the CEO isn’t the most highly paid employee. The most highly paid employee must be disclosed in what most companies call the “Summary Compensation Table” in the proxy statement. For WHR Whirlpool, the CEO Marc Bitzer’s pay was $7m, but the most highly paid employee was Jeff Fettig who got $16m. The SEC regulation calls for calculating the ratio of the CEO’s pay to the median employee pay, so WHR calculated a ratio of 356 ($7m/$20k), not 800 ($16m/$20k). Another example was OSTK Overstock.com, where CEO Patrick Byrne got $445k, and the most highly paid employee was Saum Noursalehi who got $968k.

Companies need not consider contractors, leased workers and similar “gig economy” workers to be employees. Thus it’s possible for a company to obtain a lower ratio by hiring a contracting firm which then hires all the employees paid less than, say, $150k. I found no clear evidence of an occurrence. Companies can also decline to count some workers outside the US, up to 5% of the employees. Some companies have done so.

The company with the highest ratio was LEA Lear, which makes car seats. The highly paid employee got $15m in 2017, and the median employee got $10k, and the reported ratio was 1,452.

The company with the lowest ratio was perennial startup OSTK Overstock.com. The highly paid employee got $1m, and the median employee got $52k, and the reported ratio was 8.

I found no significant correlation between pay ratio and market capitalization (size), but there was significant positive correlation between highest pay and market capitalization.

Graph: Daniel Brockman, 2018
I found very mild negative correlation between highest employee pay and the increase in stock price during the last 10 years. I found mild positive correlation between ratio and 10 year price increase, but with the small sample size, the extraordinary case of LEA Lear, with a ratio of 1,500 and a price increase of 16 times, strongly influences the correlation measure. Remove LEA and the data are uncorrelated.

Why does this matter? In the US, we have a narrative that if a person works diligently and loyally and energetically, works pleasantly with others, does work of highest quality, and deals honestly and fairly with others, then she or he can expect to prosper and to rise to even the highest office. But the disclosed pay ratios tell us a different story. What kind of annual raise in pay could such a good worker expect, with consistent performance year after year? 10%? 15%? With that kind of annual raise, after how many years will the good worker have pay equal to the most highly paid executive? This formula gives us the answer, assuming the good worker starts at the median employee pay:

Years = log( pay ratio ) / log( 1 + annual raise fraction )

At ALGN Align, for example, we calculate using an annual raise of 10%:

72 years = log(923) / log(1 + .10)

At OSTK Overstock.com, the good worker could attain the high pay after 22 years, a lifetime of work. At no other company in my set of 24 is such a short time possible. At INTC Intel, the figure is 56 years. At T AT&T, it’s 62 years. This exceeds what a person can do in a lifetime, meaning a person must do something more than or different from good work to reach the highest levels of monetary reward. Put differently, the CEOs get paid for something other than good work.

Disclosing the median employee pay alongside the highest employee pay is an important development. Some European governments require disclosure of corporate officers’ pay, though none publish typical employee pay to my knowledge. Asian companies don’t disclose these numbers. The US SEC requires the most detail and provides an example to other regulators. It will be interesting to see what diligent future researchers find in the pay ratios.

My data set of 24 companies is available at https://docs.google.com/spreadsheets/d/1M9OYJuBHkVdnFKAXq8oDDd0Neqq0-DvPE-VwoIRlr6c/edit?usp=sharing


U.S. Congress, "Michael Milken" (2006, Public Domain, Wikipedia)

Daniel Brockman, Graph (2018, freely use with attribution)


From the SEC Securities and Exchange Commission …

“Press Release: SEC Adopts Interpretive Guidance on Pay Ratio Rule” (Sep 21, 2017, https://www.sec.gov/news/press-release/2017-172)

“Commission Guidance on Pay Ratio Disclosure” (https://www.sec.gov/rules/interp/2017/33-10415.pdf, retrieved Apr 12, 2018)

“Inflation Adjustments and Other Technical Amendments” (https://www.sec.gov/rules/final/2017/33-10332.pdf, retrieved Apr 12, 2017)

“Division of Corporation Finance Guidance on Calculation of Pay Ratio Disclosure” (Sep 21, 2017 https://www.sec.gov/corpfin/announcement/guidance-calculation-pay-ratio-disclosure)

“Code of Federal Regulations, Title 17 - Commodity and Security Exchanges, Section 229.402 (Item 402) Executive compensation” (Apr 1, 2017,

“Commission Guidance on Pay Ratio Disclosure” (Sep 27, 2017,

“Regulation S-K, Questions and Answers of General Applicability” (Sep 21, 2017,

“Public Statement, Additional Dissenting Comments on Pay Ratio Disclosure” (Aug 7, 2015,

“Item 402 of Regulation S-K -- Executive Compensation, Questions and Answers of General Applicability” (Aug 8, 2007,

Other sources ...

George A. Akerlof and Robert J. Shiller, “Phishing for Phools” (2015, Princeton University Press, http://a.co/6uww373)

Carola Frydman and Raven E. Saks, “Executive Compensation: A New View from a
Long-Term Perspective, 1936–2005” (2010, Oxford University Press, http://web.mit.edu/frydman/www/trends_rfs2010.pdf)

Thomas Piketty, “Capital in the Twenty-first Century” (2014, Harvard University Press, http://a.co/fdt8GiZ)

Joseph E. Stiglitz, “The Price of Inequality” (2013, W.W. Norton, https://amazon.com/dp/0393345068)

Wikipedia, "Michael Milken" (retrieved Apr 13, 2018, https://en.wikipedia.org/wiki/Michael_Milken)

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